What drove markets

Investors reassessed the outlook for interest rates after the collapse of Silicon Valley Bank in California and New York’s Signature Bank, which left regional bank shares under heavy pressure.

Treasury yields fell sharply as investors scaled back expectations for future Federal Reserve rate increases, with the bank rout seen as potentially crimping lending activity that could slow down the economy.

“One way to look at this is that a big chunk of the Fed’s job has now been done for it,” said Brad McMillan, chief investment officer for Commonwealth Financial Network, in a phone interview.

The Fed’s goal had been to “hike rates until borrowers stop borrowing. Now one major source of borrowing in the tech sector has blown up” while regional banks will be forced to reduce their loan book, he said.

Meanwhile, the moves taken by regulators may, in the end, be enough to stem some of the turmoil in global markets emanating from smaller U.S. banks, said David Kelly, chief global strategist at JP Morgan Funds, in a note.

However, “these problems were largely set up by over-easy Fed policy for many years and are now being triggered by excessive tightening,” Kelly said.

SVB’s failure was blamed on a mismatch between assets and liabilities. The bank catered to tech startups and venture-capital firms. Deposits grew rapidly and were placed in long-dated bonds, particularly government-backed mortgage securities. As the Federal Reserve began aggressively raising interest rates roughly a year ago, funding sources for tech startups dried up, putting pressure on deposits. At the same time, Fed rate hikes triggered a historic bond-market selloff, putting a big dent in the value of SVB’s bondholdings, which it was forced to sell at a huge loss.

Read: Silicon Valley Bank is a reminder that ‘things tend to break’ when Fed hikes rates

Concerns about asset-liability matchups remain, analysts said, as regional banking stocks continued to sink. Shares of First Republic Bank 
FRC,
-32.80%
ended down by 61.8%, while Western Alliance Bancorp 
WAL,
-15.14%
dropped 47.1%, PacWest Bancorp 
PACW,
-18.95%
shed 21.1%, and Zions Bancorp 
ZION,
-6.76%
tumbled 25.9%. Larger banks took a less-drastic hit: Bank of America Corp.
BAC,
-3.97%
shares closed down by 5.8%, Wells Fargo & Co.
WFC,
-3.92%
fell 7.1%, and JPMorgan Chase & Co.
JPM,
-3.78%
was off 1.8%.

See: Regional banks are seeing flight of deposits to too-big-to-fail megabanks

Also: Why bank ETFs are tanking despite regulators taking emergency steps to backstop depositors

Short-duration government bond yields tumbled as investors made bets that financial instability will encourage the Federal Reserve to slow or pause rate hikes. A flight to quality was also contributing to the pullback in Treasury yields, which move opposite to price.

The 2-year Treasury yield
TMUBMUSD02Y,
3.824%,
which last week was trading at 15-year highs above 5%, fell 55.8 basis points to 4.03% on Monday. That was the biggest one-day decline since Oct. 20, 1987.

Need to Know: SVB’s rescue means the Fed won’t hike rates in March, says Goldman Sachs

There is “a problem of varying degrees across most (if not all) banks in the U.S.,” which represents a real threat to the system should a large-scale run develop, according to Brian Mulberry, a client portfolio manager at Zacks Investment Management, which manages $15 billion in assets.

Silicon Valley Bank and Signature Bank “failed, in part, because of a lack of interest-rate-risk management,” Mulberry wrote in an email. “These banks bought long dated bonds over the past several years and didn’t manage their duration or interest-rate risk. So, as rates rose over the past year and longer dated bonds dropped in value, it eroded their capital base and bonds they valued at par (100) were worth nothing close to it.”

Companies in focus

• Charles Schwab Corp.
  SCHW,
  -2.54%
  moved Monday to reassure investors that it has plenty of liquidity and does not need to sell any of its held-to-maturity securities over unrealized losses. Shares finished down 11.6%.

• Seagen shares 
  SGEN,
  -0.09%
  ended up by 14.5% after Pfizer Inc.
  PFE,
  -0.67%
  agreed to buy the cancer biotech for $43 billion, or $229 per share, in an all-cash deal. Pfizer’s stock finished up by 1.2%.

• The energy sector was suffering a broad selloff Monday amid worries that the recent bank failures will trigger an economic slowdown, which saps demand for crude oil. The Energy Select Sector SPDR exchange-traded fund
  XLE,
  -1.57%
  ended down by 2%.

— Jamie Chisholm contributed to this article.